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Get ready for a major market move

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Published: May 28, 2014 2:59 p.m. ET

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As VIX, the CBOE S&P 500 Volatility Index, plumbs new lows, many market observers are preparing for a major market move.

Many investors rely on the Chicago Board Options Exchange Volatility Index
VIX, +1.17%
to keep an eye on stock-market volatility. As the VIX continues to sink closer to its historic low of 9.39, many commentators are now discussing the VIX as a "complacency index." As the VIX falls, it signals increasing levels of investor complacency. Because economist Hyman Minsky taught us that periods of high volatility follow periods of low volatility, many investors are beginning to worry that a "Minsky moment" could be lurking around the next corner that would send volatility higher, increase the risk premium for holding stocks and cause prices to sink.

On Friday, May 23, the VIX ended the session at the day's low of 11.36. The increased focus on investor complacency, which followed the highly publicized interview with hedge-fund manager David Tepper, has not reduced investor complacency.

In fact, the opposite has taken place, despite Tepper's statement that: "I am nervous. I think it's nervous time." Although the S&P 500 climbed 0.42% to a record-high close on Friday at 1,900.53, the trading volume was thin — at a pre-holiday level of 1.419 billion S&P 500 shares. Unfortunately, the S&P trading volume has not been much better on the other days when it has advanced. Furthermore, a review of the S&P chart will reveal that Friday's advance was the third point of a triple-top, which included April 2 and May 13.

There are currently some signals suggesting deterioration in market breadth, as well. The advance/decline lines for the capitalization-weighted S&P 500, as well as the Nasdaq 100, are rising above their equal-weight counterparts. This narrowing of leadership signals weakening market breadth.

One trader's $13 million call spread, in anticipation that the VIX would rise above 19 in September, has attracted a good deal of publicity. Could the completion of the Federal Reserve's bond purchases in October have anything to do with the investor's expectations that the VIX will rise during September? Call options on VIX have also reached a six-year high, as the savviest traders bet on a return to higher levels of volatility.

There is no debate over the issue that the strength of the stock market has been fueled by the Fed's quantitative-easing program. Once the bond buying finally ends in October, investors will be watching the horizon for the first increase of the federal funds rate. Now that the Fed's forward-guidance agenda is underway, we will be watching that horizon with a brand new pair of binoculars.

Despite the recent record highs for the S&P, investors were shocked to see the earnings misses and (in most cases) gloomy guidance from Staples
SPLS, -1.86%
Dick's Sporting Goods
DKS, -0.76%
UrbanOutfitters
URBN, +0.83%
and TJX
TJX, +0.21%
on May 20. Home Depot
HD, +0.02%
was the only retailer with a positive earnings report last Tuesday. Because the United States economy is 70% consumer-driven, any slump in consumer demand immediately raises concern about where the stock indexes may head in the future.

This week's economic calendar brings a deluge of data, including a first-quarter GDP revision on Thursday, and personal income and spending, Chicago PMI and University of Michigan consumer sentiment on Friday.

Of these, the most important will likely be the first-quarter GDP due on Thursday. The last estimate was for growth of 0.1%, while expectations for the revision are a -0.6% decline in growth for the first quarter. A decline here would be an unwelcome development, as two consecutive quarters of negative GDP is the official definition of recession. While this will probably be blamed on bad winter weather, a slip into recession could easily trigger the next "Minksy moment" and escalate market volatility. I remain cautious as we enter the lazy, hazy, crazy days of summer.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
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from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.